DIGL Founder: $348M in Insider Sales

Just when you thought you'd heard every story of outlandish executive enrichment in the telecommunications industry, along comes a real jaw dropper.

Ready? At the latest tally, it appears that Bryan Zwan, chairman and founder of Digital Lightwave Inc. (Nasdaq: DIGL), has taken no less than $348 million out of the company. Meanwhile, Digital Lightwave's business has collapsed, it has a market capitalization of less than $40 million, and it's now almost trading as a penny stock, at $1.22.

Zwan moved the money via arrangements to sell his stock at fixed prices across complex strings of transactions involving: a Nevada company he controls, ZG Partnership; investment bank Credit Suisse First Boston Corp. (CSFB); and one of the bank’s subsidiaries, CSFB SAILS Corp. This is according to several 13D forms filed with the Securities and Exchange Commission (SEC) over the course of the last few years.

Just Tuesday, Zwan, who is the controlling shareholder of Digital, stepped out of the CEO post for the second time, moving back upstairs as the company's chairman. His tight control over the company, the company's falling fortunes, and his affiliation with the Church of Scientology has made his leadership a popular item of debate (see Losses, Lawsuits, and Scientology).

Over the years, Zwan made arrangements to lock in gains for sales of millions of shares of stock at prices ranging from $31 to $121, raising $23.8 million in cash for himself and another $348.5 million in guaranteed purchase agreements for his company, ZG Partnership, of which he is the sole owner and president, according to the SEC filings.

Investment banking and hedge-fund experts consulted by Light Reading say Zwan's technique, though bordering on the extreme, is not unusual. Many executives use sophisticated arrangements involving limited partnerships and investment banks to lock in gains on stock. But the sheer magnitude of Zwan's sales -- which in dollar terms now amount to nearly ten times the current market capitalization of his company ($38 million) -- is astounding, say experts.

Nearly all investment banks work with executives to come up with arrangements to hedge positions or "forward sell" stock, which usually involves the banks fronting money for the stock while they protect themselves with hedging instruments [ed. note: not to be confused with the Strimmer™ or pruning shears].

Though Zwan's particular deal appears to be more complicated than most, here's how such deals usually work: An insider goes to an investment bank, looking to sell shares of the stock without actually putting them on the open market. The investment bank grants a "forward purchase" agreement guaranteeing the seller a price at some future point in time. Then, in order to hedge itself against the stock falling, the investment bank usually "short-sells" the stock or buys options that would rise in value if the stock falls.

What makes Zwan's case interesting is the number of shares involved (at least 4.5 million) and the fact that he is the majority shareholder of the company, owning some 60 percent of the stock. As Zwan and ZG Partnership were "forward selling" millions of shares of stock to the investment bank, the investment bank likely had to short-sell the stock (sell shares it did not yet own) to hedge its bet. If this was the case, the transactions would have resulted in enormous selling pressure on Digital Lightwave's stock.

It's not clear what action CSFB took. CSFB declined to comment for this article. According to SEC filings and Zwan himself, he still controls all of the stock at issue in the forward purchase agreements. At some point in the future he will need to hand over control of certain numbers of the shares in the agreements, depending on the market price, beginning in 2004, according to SEC filings.

By going through ZG Partnership, Zwan did not have to declare, in his own name, the cash value of the transactions involving Digital Lightwave stock in filings to the SEC. Zwan did disclose that he was transferring 4.5 millions shares of DIGL to ZG Partnership's control in several "non-market" dispositions; these transfers were disclosed in SEC 144 forms filed in 2000 and 2001. Other insider transactions registered in Zwan's name show that Zwan purchased 992,000 shares at prices of between $4.91 and $5.249 a share (a total cost of about $5,039,000) in February 2002, according to SEC filings.

The complicated ways in which Zwan has sold Digital Lightwave stock are evident in a 13D form filed with the SEC on May 13, 2002. It started with 4.56 million shares of Digital Lightwave stock that Zwan unloaded to ZG Partnership by means of the "non-market disposition." Then, in a series of transactions, "forward purchase agreements" for massive lots of stock (millions of shares) were moved among ZG Partnership, CSFB, and CSFB SAILS Corp., usually in exchange for cash amounts specified by purchase agreements.

At any rate, just figuring out what was going on takes some careful reading. The 15-page 13D filing outlines a complex series of deals. One of the transactions went like this:
On December 8, 1999, Dr. Zwan entered a "forward sale
agreement," by which he pledged 1,000,000 shares to CSFB SAILS Corp. and CSFB.

Says the filing:

Pursuant to the Zwan Agreement, Dr. Zwan received a purchase price of $23,790,580. In connection with the Zwan Agreement, Dr. Zwan entered into the Pledge Agreement dated December 8, 1999 among Dr. Zwan, CSFB SAILS Corp. and Credit Suisse First Boston Corporation. Up to 1,000,000 shares are subject to this pledge agreement.

Other agreements in the filing, 11 in total, paint a more complex picture, one in which the ZG Partnership then placed its own "forward sale" agreements with CSFB, at the same time as it was buying shares on the open market. In these transactions, ZG received cash from CSFB.
For example, on February 9, 2000, ZG Partnership entered into a term sheet outlining the terms of forward sale arrangements with respect to 1,500,000 shares of stock with CSFB. In a related transaction, on March 1, 2000, ZG Partnership entered into a forward sale agreement for 750,000 shares of stock.

Says the filing:

In consideration therefore, ZG Partnership received a purchase price of $38,152,131.00. In connection with Agreement I, ZG Partnership entered into the Pledge Agreement dated March 1, 2000 among ZG Partnership, CSFB SAILS Corp.

In February and April of 2001, ZG registered with the SEC to sell 2 million shares of Digital stock for a total of $93 million.

A Digital Lightwave spokesman, Paul Harris, confirmed that ZG Partnership is connected with Dr. Zwan but said it is of no concern to the company: "I see what you see. He controls this ZG Partnership. I don't comment on Dr. Zwan's personal business."

Zwan commented through his lawyer, and information he shared was included in an update of this story.

There are no government investigations into these dealings, according to available information. The SEC already threw out a March 2000 complaint that it filed against Zwan. Light Reading is not aware of any shareholder litigation arising from Zwan's sales of Digital Lightwave stock.

Zwan puts the recent losses and reduced revenue at the company to an “unexpected sales decline” in the second quarter (see Digital Lightwave Reports Q2).

re: DIGL Founder: $348M in Insider Sales I was very concerned as to why this guy rejoined the company after nearly two years of absence. The main reson he joined the company as CEO so that he could easily direct the sale of his stocks.

There are thousands and thosands of companies that have engaged in unethical/ilegal practices. Due to lack of rtesources and lack of commitment, the US government has not been pursuing these corporate theives effectively.

To circumvent the existing laws, many CEOs have modified the statement: " I certify the accuracy of the company books". Some CEOs have prefaced their staments by adding an addendum by stating: " To the best of their knowledge I cerify to the accuracy of my account" . This leaves a very wide gp for many many company CEOs to engage in corrupt and dishnest practices.

The news from Digital Lightwave should be an eye opener to the enforcement authorities.

Not much is happening in terms of vigilance in spite of the fact that most of the high-tech companies have lose close to 80% of their value.

Unless the government offers total protection to the whistble blowers from getting fired, the shareholders will not be protected from these corporate crooks.

re: DIGL Founder: $348M in Insider Sales Dr. Zwan does truly illustrate all the evil much of the "new economy" is claimed to have brought to peoples lives and fortunes. We have the idiots and class-less thieves like CFO's at Enron and Worldcom, we have the fast-talkers like Ken Lay and we have the rapists like Dr. Zwan.

Looking at the ratio of how much stock an individual sold in the past relative to the CURRENT market capitalization is completely irrelevant and being used by people like LR to create sensational headlines.

Take the current subject: what LR seems negligent in not disclosing is that if he did sell 4.5 million shares over time, that only represented about 20% of his holdings. That is not at all an unreasonable amount of shares for an individual to want to sell.

It would also seem that he complied with all the necessary disclosure rules.

Now I do think you have a point if you want immediate (or advance) disclosure of insider sales. Also, if he tried to mask sales through a third party partnership that is not kosher. But program sales through CSFB, that is fine as long as it is all disclosed.

You as an investor have to be smart enough to avoid situations where there is concentrated stock ownership. That information is disclosed.

BTW, to say that an individual rejoined a company to make his stock sales easier is ridiculous - he is subjecting himself to more severe blackout restrictions, etc.

Sure, it may have been only 20% of his holdings, but he owns 60% of the entire company.

as I was the reporter, let's just talk about some facts:

$345M in stock sales

DIGL's past 12 months of sales = $54MPercent of public "float" of DIGL stock that Zwan sold = 30%

We wrote this story because by any measure, the numbers are large. The Chairman sold more $$ in stock than the company has in annual revenues. With only 12 million shares in the public float, he also put the equivalent of 30% of the public float of the stock on the market. Ask any Wall Street professional, and he/she will tell you that is extremely rare.

re: DIGL Founder: $348M in Insider Sales Smart business move. He founded and built this company and has reaped the rewards. You can present all the facts you want but the bottom line is he made a smart move. The $1.22 stock price and low revenues is not the result of him profiting from selling his stock/ options.

re: DIGL Founder: $348M in Insider Sales > Smart business move. He founded and built this > company and has reaped the rewards. You can > present all the facts you want but the > bottom line is he made a smart move. The $1.22 > stock price and low revenues is not the result > of him profiting from selling his stock/ > options.

The $1.22 stock price and low revenues are proof that he built nothing else than a vehicle to bilk investors (a-la Ponzi's post reply coupon business).

However, the aberration here is that a company that had $54 million in LTM sales, traded at around a $4 billion market cap. NOT that the CEO sold 20% of his position. In fact the CEO or any employee would have to be brain dead not to sell around 20% of their holdings, particularly if they have a large part of their net worth in this stock.

Before I passed through purgatory I was a "Wall Street professional" and in situations with little float and high stock concentration you want to get those shares into the public hands to lower the volatility of the stock. In fact if you wanted to make a totally self serving arguement (but I won't) you could say that he was helping the shareholders by increasing the float and hence lowering volatility (didnt work). However, a secondary offering is a much more traditional way of doing that. But I wander...

I am not defending this guy, perhaps he does belong in jail, but not because of some meaningless and misleading ratio that compares his stock sales to his company's revenue.

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